Today we'll evaluate ARC Document Solutions, Inc. (NYSE:ARC) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for ARC Document Solutions:
0.056 = US$15m ÷ (US$364m - US$89m) (Based on the trailing twelve months to September 2019.)
So, ARC Document Solutions has an ROCE of 5.6%.
Does ARC Document Solutions Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see ARC Document Solutions's ROCE is meaningfully below the Commercial Services industry average of 9.9%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how ARC Document Solutions stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
ARC Document Solutions's current ROCE of 5.6% is lower than its ROCE in the past, which was 8.9%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how ARC Document Solutions's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is ARC Document Solutions? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How ARC Document Solutions's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
ARC Document Solutions has total liabilities of US$89m and total assets of US$364m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On ARC Document Solutions's ROCE
That's not a bad thing, however ARC Document Solutions has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than ARC Document Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like ARC Document Solutions better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.